May 2017

The euro’s economic architecture is still incomplete, meaning that any number of large shocks could reignite the crisis in the Eurozone. This column introduces a new VoxEU eBook which summarises the main issues that need to be addressed to make the euro work and identifies, for each issue, the degree of consensus among experts.

Brexit is likely to cause considerable disruption for financial markets. Some worry that it may also increase systemic risk. This column revisits the debate and argues that an increase in systemic risk is unlikely. While legal ‘plumbing’ and institutional and regulatory equivalence are of concern, systemic risk is more likely to fall due to increased financial fragmentation and caution by market participants in the face of uncertainty.

Real hourly wage growth has behaved quite differently across countries over the past ten years. This column describes how the majority view of the latest Centre for Macroeconomics and CEPR expert survey is that low growth of real wages has had a positive impact on European employment rates during the recovery phase of the Great Recession. A strong majority of respondents also agrees that the dire performance of UK real wage growth relative to the big Eurozone economies is in large part due to the UK’s labour market policies, which provide workers with comparatively weak protection.

While non-US entities pay dollar funding premiums in the FX swap market, the US earns profits on FX-hedged investments in non-US sovereign securities. This column argues that this new form of the ‘exorbitant privilege’ presents a modern version of the ‘Triffin dilemma’. If the distributional effect of US privilege becomes large enough to induce non-US entities to take excessive risk, the stability of the global financial system will come under threat.

In April 2017, the US House of Representatives passed a bipartisan revision of the bankruptcy code, which would expedite the resolution of adequately structured intermediaries. This column considers the new Financial Institutions Bankruptcy Act of 2017 and how it fits in with the existing Dodd-Frank mechanism. By raising the odds of an effective resolution, the Act (as a complement to Dodd-Frank) boosts the credibility of the US regime. However, in the absence of an Orderly Liquidation Fund-like provision for temporary government funding, investors and foreign regulators will expect a future US government to re-introduce an ad hoc bailout mechanism when it is inevitably needed.

The Greek crisis is typically seen as a sovereign debt crisis. Using a new dataset, this column explores the dynamics of national wealth accumulation in Greece over the past two decades. It argues that, despite certain idiosyncrasies, the Greek crisis can be better characterised as a balance of payments crisis. This implies that Greece shouldn’t be seen as an outlier amongst the periphery Eurozone countries.

It is high time to forget some economic ideas that hinder progress in the field. Some examples include the assumption that GDP is the best way to measure economic progress, or the belief that economic growth will eventually improve the welfare of the population as a whole. This column discusses some of these ideas and argues that economics is a progressive science that is enriched by the ‘creative destruction’ of ideas.

The new resolution and bail-in regime in Europe hypothetically lets banks fail without resorting to public funding. This column examines the effects of the bail-in of the Portuguese Banco Espírito Santo. Existing borrowers from the banks exposed to the bail-in experienced a negative impact on their credit supply from these banks, but were able to compensate with increased borrowing from other, less-exposed banks. Nevertheless, the bail-in had negative real economy consequences with affected firms reducing investment and employment, while increasing precautionary cash holdings.

Classical models suggest that shifts in the balance of power can lead to conflict, where the established power has the incentive to trigger war to deter the threat to its dominance. This column argues that this changes if international trade is taken into account. Industrialisation requires the import of natural resources, potentially leading a smaller nation to trigger war either against a resource-rich country or the incumbent nation. The model can help explain the US-Japanese conflict of 1941 and Hitler’s invasion of Poland, and has implications for US-Chinese relations today.

Since 2000, political uncertainty has had a strong influence on market volatility in the US. Since Donald Trump became president, however, high policy uncertainty has not translated into high market volatility. Building on a theoretical framework linking stock prices and political news, this column argues that the US market does not respond to political uncertainty because political news coming from the new administration has been unreliable and difficult for investors to interpret.

The economic effects of foreign direct investment are generally expected to be positive for the host economy. However, this is usually conditional on certain thresholds of development being met, for instance in terms of human capital or institutional quality. This column argues that the economic impact of foreign direct investment is less ‘conditional’ than commonly thought, perhaps because below the thresholds, the difference between private and social returns is substantial, while above them it is smaller.

The future of publicly funded welfare states is in doubt as costs trend upward, yet there is little agreement about the shape of the necessary reforms. This column uses the case of New Zealand to show how tax cuts can be designed to establish compulsory savings accounts so that a publicly funded welfare system can be changed into one that relies largely on private funding. Transparent pricing of services can be introduced, offering the potential for efficiency gains. The government retains sufficient revenues to act as ‘insurer of last resort’ for those individuals unable to meet welfare expenses out of their savings accounts.

Much progress has been made in recent years to improve the financial integration of the Eurozone. This column argues that while banking union promotes stability, markets remain fragmented and consumers aren’t yet fully enjoying the fruits of integration. With Brexit on the horizon, it is up to the remaining EU member states to foster competition and efficiency in financial services by completing the banking union, harmonising national regulation, and accelerating the realisation of a true capital markets union.

Bank risk-weighted assets differ significantly across banks. Using a unique database covering Europe’s top 50 banking groups, this column argues that national segmentations explain a significant (albeit decreasing) share of this variability. Furthermore, institutions that rely more heavily on the internal ratings-based approach have reduced more (or increased less) their corporate loan portfolio. This effect is somewhat stronger for banks located in Eurozone periphery countries during the 2010-12 sovereign crisis.

In recent years, several US states have introduced college admission policies that reward local rather than global relative performance by guaranteeing admission to students graduating in the top N-percent of their high school. This column examines how these policies affected socioeconomic and ethnic segregation at both the university and high school levels in the state of Texas. While the policies did not replicate the level of diversity in universities seen under earlier affirmative action policies, they did lead to a reduction in the overall level of ethnic segregation in high schools.

Almost 20 years after CEPR published “Social Europe: One for All?”, Social Europe has moved again to the top of the policy agenda. In this column, two of the authors revisit their report and argue that the challenges posed by the Global Crisis, the deepening of the inter­nal market, globalisation, technological progress, popu­lation ageing, and the refugee crisis now require a more effective strat­egy to strengthen the EU social acquis.

Widening global imbalances, driven by reserve accumulation, can help us investigate how real exchange rates are determined. Standard theory would predict real exchange rate appreciation when there is an increase in net foreign assets. This column uses recent data from 75 countries to argue that, in practice, there is the opposite correlation in the particular case of reserve accumulation, notably in countries with higher capital controls and in developing countries.

Despite higher per capita healthcare spending, US health outcomes compare poorly with other developed nations. One potential reason is that the US healthcare system creates incentives that promote the faster adoption of medical technologies with minimal benefits. This column tests this claim using data on the quality and diffusion of new pharmaceuticals in the US and four other countries. The results suggest that compared to Australia, Canada, Switzerland, and the UK, low-quality drugs diffuse more quickly in the US relative to high-quality drugs.

The pervasive ‘hearts and minds’ theory guiding counterinsurgency doctrine contends that military-led reconstruction reduces violence in post-conflict settings. Using rare data from Afghanistan, this column questions the theoretical and empirical basis of that perspective. Military-led projects in the health sector are found to successfully alleviate violence, whereas those in the education sector actually provoke conflict. The destabilising effects of education projects are strongest in conservative areas, where public opinion polls suggest education projects breed antipathy towards international forces.

Behavioural economics has identified phenomena that standard models could not explain. But its critics warn that it is becoming little more than a ‘pile of quirks’. This column argues that the future development of behavioural economics should focus on a streamlining process that will clarify core issues, fill conceptual gaps, and create tractable models. Behavioural models will only become a coherent alternative to homo economicus if this process occurs.

Putting a number on how effective policymakers are in boosting cross-border trade is important. But doing so in a statistically sound way is not trivial. This column presents a new methodology to identify the causal effect of preferential economic integration agreements. It finds trade effects that are somewhat smaller than predicted by established, but problematic, procedures.

The quality of English language teaching in Japan is disappointing when compared with other East Asian countries or with the quality of other school subjects. This column assesses the impact of an English learning programme via Skype for Japanese high school students. Although a positive impact on English communication skills could not be established, mostly likely due to the low utilisation of the programme, it did have a positive impact on student attitudes. Policymakers may wish to consider how to combine regular English lectures and online English learning programmes to improve results.

Inflation has been shown to co-move across countries, but whether this is due to common shocks or propagation via real and financial channels has not been established. This column argues that global value chains propagate cost pressures across borders, thereby synchronising inflation. As international input linkages represent a direct link between foreign marginal costs and domestic production costs, their prevalence has a significant effect on the extent to which optimal monetary policy is inward-looking.

The 2017 CEPR European Workshop on Household Finance took place on 28-29 April 2017 at the Copenhagen Business School. This column introduces the CEPR Network on Household Finance and its goals, and also describes the papers that were presented at the workshop.

The sluggish growth of the US economy after the 2014-2016 decline in the oil price surprised many economists. This column argues that it should have been expected. The modest stimulus to private consumption and non-oil business investment was largely offset by a large decline in investment by the oil sector. Growth was further slowed by a simultaneous global economic slowdown, reflected in lower US exports.

Economists are judged on both the number of times they publish and where they publish. Yet very little is known about the impact on reputation of including lower-rated journals in an author’s list of publications. This column presents evidence that including these publications has a negative impact on judgements of the author’s contribution by other economists. To the extent that such judgements may influence research and publication strategies, the findings imply negative implications for social welfare.

There has been speculation that the dollar may soon be displaced by the euro or renminbi as the primary international currency. This column examines the demise of silver-based monetary standards in the 19th century to explore price dynamics when a money ceases to function as a global unit of account. According to new data on the historical prices of agricultural commodities, silver ceased functioning as a global price anchor in the mid-1890s. Over the same period, the volatility of agricultural commodity prices also declined.

Disentangling the relationship between management practices and productivity has been hampered by the absence of large sample data across plants and firms. This column exploits a new survey covering US manufacturing to show that management practices vary both among and within companies. Furthermore, management practices are just as important for productivity as a number of other factors associated with successful businesses, such as technology adoption.

Recent empirical studies of the effects of immigration have tended to focus on short-run outcomes. This column considers the longer run by examining how mass migration at the turn of the 20th century has affected US outcomes today. Higher historical immigration between 1860 and 1920 is found to result in significantly better social and economic outcomes today. The results suggest that the long-run benefits of immigration can be large, can persist across time, and need not come at a high social cost.

Since the Global Crisis, private credit has risen sharply in several emerging market and developing economies as well as advanced economies. This column examines the role of investment alongside these credit booms, and how output growth has been affected. These booms have been unusually ‘investment-less’ in comparison to previous episodes, which were accompanied by investment surges. The absence of investment surges during credit booms is accompanied by lower growth, especially once the credit boom unwinds.

The capital–income ratio continues to rise. This increases interpersonal inequality when three conditions are met (as they are in all rich economies today): the rate of return to capital outstrips that of income, income from capital is concentrated among the rich, and the income source that is less equally distributed is correlated with overall income. This column argues that the third condition is not inevitable, and that policies to share income from capital more equally would decrease overall inequality. We have tools to do this, but policymakers lack the political will.

Some firms pay well while others don’t; and some are highly productive while many aren’t. This column presents new firm-level data on the increasing dispersion of wages and productivity in both the manufacturing and services sectors in 16 OECD countries. Wage inequalities are growing between firms, even those operating in the same sector – and they are linked to growing differences between high and low productivity firms. Both globalisation and technological progress (notably information and communications technologies) influence these outcomes – as do policies and institutions such as minimum wages, employment protection legislation, unions, and processes of wage-setting.

In the aftermath of the Global Crisis, sovereign yield differentials have increasingly widened among European developed countries. Financial markets seem to discriminate among peripheral economies requiring a higher risk premium than is justified by fiscal factors only. This column discusses the causes of this phenomenon. In peripheral countries, it is not due simply to the lack of fiscal discipline, but to a combination of both internal and external imbalances.

Large numbers of traders share their thoughts about the euro-dollar exchange rate on Twitter. By identifying and classifying opinionated tweets, and constructing a daily measure of sentiment, this column shows that a trading strategy that takes long or short positions based on the forecasts of high-follower accounts provides a Sharpe ratio significantly above that of the carry trade. The methodology could easily be applied to other currencies or portfolios of currencies, as well as other financial markets such as the stock market.

Selective schooling (or ‘tracking’) seeks to improve efficiency in education by tailoring curricula to students’ needs, but opponents argue that it can lead to segregation and lifelong disadvantages. This column draws on evidence from Germany to argue for the importance of flexibilities in any new system of selective education, as with the UK’s proposed reintroduction of grammar schools. Substantial disadvantages in terms of teaching curriculum and peer exposure do not need to have long-term consequences, as long as the education system allows revising initial choices at later stages.

While the impact of modern technological change on the skill premium has been well explained, there has been no study of the evolution of the skill premium over the very long run. This column reveals that the skill premium in Western Europe declined between 1300 and 1600, and converged to a low and stable level afterwards. Growth and technological change, while stimulating economic development and the transition from a pre-modern era to modern era, reduced wage inequality between different working groups.

Recoveries from recessions in the US used to involve rapid job generation, but job growth has failed to match GDP recovery after recent US recessions. This column examines the role of technology in this and asks whether jobless recoveries are a wider problem outside of the US. In the US, industries that are more prone to technological change experienced slower job growth during recent recoveries, but it appears unlikely that modern technologies are causing jobless recoveries outside of the US. This poses a puzzle as to the nature of recent jobless US recoveries.

In recent speeches, Federal Reserve Chair Janet Yellen and ECB President Mario Draghi have attributed the Fed’s and the ECB’s low interest rate environment to low equilibrium rates rather than to Fed or ECB policies. This column argues that estimates of these equilibrium rates are extremely uncertain and sensitive to technical assumptions, and thus should not be used as key determinants of the policy stance. But if used nevertheless, a consistent application together with associated output estimates call for a tightening of the policy stance.

There has been growing recognition that emerging markets may benefit from more proactive management of capital flows, and thus avoid crises when the flows recede. But do they do this in practice? By analysing policy responses in a sample of emerging markets, this column argues that central banks respond to capital inflows through various tools. Ironically, the most commonly prescribed instrument for coping with capital inflows – tighter fiscal policy – is the least-used tool in practice.

As the recovery in the Eurozone approaches its fifth year, this column presents the latest economic forecast from the European Commission, which projects a continuation of the recovery at a steady pace (1.7% in 2017 and 1.8% in 2018). Nevertheless, over the next two years, wage growth is expected to remain constrained, the investment gap is expected to persist, the current account surplus is forecast to remain high, and core inflation to stay subdued. This suggests that there is still scope for higher growth without triggering inflationary pressures, and the Spring forecast shows that maintaining the current supportive macroeconomic policy environment is the right approach, while implementing comprehensive and productivity-enhancing structural reforms. The main immediate priority should be cleaning up the banking sector.

New trade deals for the UK will be an important part of the Brexit negotiations, not only with the EU but also with the rest of the world. This column argues, however, that the UK has no trade-enhancing alternative to an agreement with the EU that essentially mimics its current situation as an EU member. A gravity model predicts that the negative impact of Brexit would be only marginally offset by a bilateral trade agreement with the US, and even in the case of trade agreements with all non-EU countries, the UK’s value-added exports would still fall by more than 6%.

As low- and middle-skill jobs disappear from the labour market, a major policy objective is to help students gear their education towards higher-skilled, higher-paying jobs. This column examines how aware US college students are of differing salaries and job prospects, and how they influence the choice of degree major. Earning potential and job prospects appear less important than enjoyment of and proficiency in a subject, possibly reflecting that students feel underinformed about the salaries and job status of alumni from their college.

International comparisons of private household wealth place the US among the richest countries, whereas German households appear rather poor. This column argues that as these rankings are based on average household net wealth, they do not tell the whole story. An augmented wealth approach that adds social security wealth to net wealth reduces wealth inequalities in both countries and the wealth gap between the two.

There is little empirical evidence that specialised banks are less stable or perform worse, as suggested by standard portfolio diversification theory. This column uses new data to argue that more specialised banks between 2002 and 2012 did not perform as theory would suggest. More specialised banks, and banks with similar sectoral exposures to their peers, suffered less volatility and had lower exposure to systemic risk. The lack of post-crisis regulatory reform in this area may, accidentally, have been a good thing.

Over the last 200 years, new machines have increasingly replaced humans, and even advanced tasks like speech recognition and translation can now be performed by relatively cheap computers and smartphones. This column describes how labour-saving technology appeared to play a key role in one of the most dramatic cases of labour unrest in recent history – the Swing riots in England during the 1830s – serving as a reminder of how disruptive new, labour-saving technologies can be in economic, social, and political terms.

Trust in our partners is important for economic transactions, but time pressure might affect the level of trust we place in others. This column reports the results of an experimental game in which individuals choose how much trust to place in partners who either must respond instinctively, or have time to reflect. Less-reflective personality types incorrectly trusted their partners least when those partners had time to think. This has implications for policies which, for example, impose cooling-off periods on negotiations.

The debate over regional trade agreements is ongoing. It has been argued that they can heighten exposure to shocks as they lead to more specialisation, and conversely that they can alleviate volatility by improving policy coordination within the anchors of a formal trade contract. This column suggests that the benefits from lowering long-term growth volatility tend to dominate potential costs, with the magnitude of this effect depending on the depth of the regional integration and the development stage of trade partners.

Inflation-targeting central banks commonly fail to hit their official inflation targets, so targets are combined with a tolerance band which is either implicit or explicit. Taking the Swedish Riksbank as an example, this column argues that adopting an explicit tolerance band would better communicate to the public the central bank’s lack of full control over the rate of inflation and thus foster public confidence in monetary policy, and it would also increase the central bank’s ability to stabilise the economy. The width of the band can be derived from the historical inflation outcome.

Contemporary businesses are frequently challenged to invest the profits from their commercial successes into projects that benefit society. Yet this is not a new concept – this column reports that it began as early as the medieval period. Profits from property speculation in the Middle Ages were re-invested into local communities. Compassionate capitalism involved high levels of charitable giving to hospitals, monasteries, churches, and colleges, which helped to disseminate the economic benefits of investments from individuals to the wider community.

Developing countries around the world are implementing structural reforms and pro-competitive policies to promote growth, but the impact of this on gender equity is unclear. This column examines the case of India, one of the world’s fastest growing countries, and finds that gender equality has not improved. Policymakers must do more to eliminate gender discrimination. They have an opportunity to not only improve the allocative efficiency of factors and increase growth, but also create an environment of equal opportunity for all, by targeting domestic market competition.

A universal basic income as a poverty-reduction policy is often contrasted unfavourably with targeted transfers. This column argues that five of the common arguments employed against basic income are really straw men that overstate the relative effectiveness of targeted transfers. While a universal basic income is not yet feasible in many countries, more universality and less fine targeting would create better social policies.

One of the defining features of the ‘American Dream’ is the ideal that children have a higher standard of living than their parents. This column examines rates of ‘absolute income mobility’ – the fraction of children who earn more than their parents – to assess whether the US is living up to this ideal. Rates of absolute mobility have fallen from approximately 90% for children born in 1940 to 50% for children born in the 1980s. Most of this decline is driven by the more unequal distribution of economic growth rather than the slowdown in aggregate growth rates.

Fixed exchange-rate regimes reduce uncertainty, which may increase trade and encourage investment and capital flows. This column identifies and tests one reason why markets expect countries to abandon pegs and devalue their currencies – shocks to the value of their output. During the classical gold standard era, commodity price fluctuations determined expected devaluation by investors, as measured by currency risk. These results highlight how trade shocks in an integrated world may undermine fixed exchange rate regimes under limited fiscal adjustments.

When empirically modelling the US demand for money, Milton Friedman more than doubled the observed initial stock of money to account for a “changing degree of financial sophistication” in the US relative to the UK. This column discusses effects of this adjustment on Friedman’s empirical models. His data adjustment dramatically reduced apparent movements in the velocity of circulation of money, and it adversely affected the constancy and fit of his estimated money demand models.

The leading candidate in the French presidential election is advised by two frequent contributors to VoxEU.org – Jean Pisani-Ferry and Philippe Martin. This column presents a selection of their writings that help show their thinking on some of the most important topics facing France and Europe today.

In the 2012 US presidential election, Mitt Romney famously asserted that 47% of the population were long-term dependents of the government – ‘takers’, not ‘givers’ to the system. This column examines this claim using long-spanning household-level data. Even though many households find themselves not paying tax or receiving public benefits in at least some years, only a small fraction consistently pay no tax or consistently receive public transfers.

Cognitive skills are often considered the key to financial wellbeing. Less weight is put on noncognitive skills. This column shows how a lack of conscientiousness, stress resistance, non-impulsiveness, or grit can explain economic fragility in households. When members possess these noncognitive skills, the household is more likely to save, less likely to have excessive unsecured debt, and less likely to be in financial distress.

Despite the significant role of housing government-sponsored enterprises in the US mortgage markets, their activities have not been subject to much scrutiny by macroeconomists. Using a monthly sample covering 40 years, this column asks how portfolio mortgage purchase activities have affected the availability of housing credit and key aggregate variables. The results indicate a key role for the agencies in shaping the US economy, as well as significant interactions and similarities between housing credit policies and conventional monetary policy.

There is concern about the persistent slowdown of economic growth in the aftermath of financial crises. This column presents a framework which shows that excessive debt accumulated by firms and households during a crisis can cause persistent stagnation. Relief from excessive debt has a direct impact on economic growth, whereas unconventional monetary and fiscal policies cannot directly solve the fundamental debt problem.

Until recently, the independence granted to the Bank of England 20 years ago had gone unchallenged. But the financial crisis has raised questions over whether central bank independence is necessary, feasible, and democratic. This column revisits the relationship between inflation and the operational and political independence of the central bank in advanced economies. The findings support the Bank of England model of monetary policy independence: fully operationally independent, but somewhat politically dependent. To make operational independence work, however, further reforms are needed to the model in both monetary–fiscal coordination and macroprudential policy.

The number of hours the average person sleeps has declined over the past century, yet the effect of sleep deprivation on economic activity and economic performance has received little attention. Using a dataset covering 14,000 families, this column investigates the link between employment outcomes for mothers and quality of sleep, measured by the number of times their children wake up at night. The results suggest that improving mothers’ average nightly duration of sleep has a positive impact on employment rates, number of hours worked, household income, and job satisfaction.